In this issue:

• Assets Transferred Before or After Death?
• Why Are Tax Refunds Shrinking?
• What To Do Before Forming an LLC
• Social Security Benefits and Location, Location, Location

Assets Transferred Before or After Death? Are you thinking of transferring ownership of assets to your children or others while you’re still alive? Don’t create a potential tax trap for the recipients of your generosity by ignoring the advantage of the “Step-Up” basis.

A “Step-Up” basis is when the value of an inherited asset may increase to its fair market value (FMV) at the owner’s death. We will use a vacation home as an example, but assets could include stocks, mutual funds, bonds, real estate, and other investment property.

If I purchased a vacation home for $300,000, my “basis” is what I paid (plus any improvements made). Some years later, I sold it for $550,000. Assuming no additional improvements had been made, I would have to pay capital gains tax on the difference between what I bought and sold it for. So, I would pay capital gains tax on $250,000.

Let’s say instead of selling the vacation home, I keep it until I die. My heirs’ basis in the house is not what I purchased it for ($300,000); it’s the FMV value of the asset at the time of my passing (you can also elect the FMV date on the 6-month anniversary of death if that’s more beneficial). So now, when my heirs go to sell it (assuming the FMV doesn’t exceed the FMV at my time of death), they won’t owe capital gains tax on the sale because of the stepped-up basis. Sweet!

As mentioned at the onset, the step-up basis for an asset is lost when you transfer ownership of the asset to your children (or others) while alive. Granted, there are valid reasons why you may want to transfer an asset while you’re still alive. Just know that when a transfer like that happens, your cost basis transfers with it. So, using the above example, instead of having a step-up basis of $550,000 as they would after your death, they would retain your cost basis of $300,000. When they sell it, they would have to pay the tax on the capital gain.

So, if there are assets you plan on passing along to your heirs, remember that if you hold them in your name until your death, they can be transferred to your heirs tax-efficiently using the step-up basis.

Why Are Tax Refunds Shrinking? According to the IRS, tax refunds are almost 29% smaller this year than in prior years. Some attribute this to changing tax laws when, in reality, the tax laws haven’t changed that much since 2018. So why are the refunds smaller?

Before you blame the tax code, ask yourself, could the real culprit be how we’re filling out our updated W-4 withholding forms? With tax laws relatively stable since 2018, the dramatic refund drop might indicate our misunderstanding of income tax withholdings.

The IRS provides a tax withholding estimator if you want to check exactly where you are with your withholdings versus your estimated tax during the year. Also, don’t forget to review your state tax withholdings.

The worst surprise is an end-of-year tax surprise, so using the withholding estimator will help avoid that.

What To Do Before Forming an LLC. I’ve had potential clients approach me with their newly minted EIN Confirmation Letter (CP575) from the IRS before they’ve even secured approval for their LLC business name from the Secretary of State. They want me to help them apply for the LLC business name on the Secretary of State’s website, for which they’ve already received the EIN. You guessed it. Sometimes, they get approval for their original business name. Sometimes, they don’t get approval and must submit additional names until the Secretary of State approves one. Then, they must apply to the IRS for another EIN using the actual name approved by the Secretary of State. Lesson learned? First, get approval from the Secretary of State for your LLC business name, and then apply to the IRS for the Employer Identification Number (EIN).

But there’s something else you should do before forming an LLC. Before you head to your Secretary of State’s website to form an LLC, determine if your business idea is feasible. This is done with a financial forecast. You should always start with the forecast because if it doesn’t make sense, there’s no point in creating a business.

A financial forecast projects what your business will look like in the future based on assumptions, such as the price of what you’re selling, how much you will sell, and the cost to market it.

The forecast is important because it helps test the practicality of these assumptions. For simplicity’s sake, let’s say you want to sell a product for $10. The cost for you to make it is $5. You want to profit $10,000 per month. A financial forecast will help show you that you would need to sell 2,000 products monthly. Given the market and what you’re selling, is that practical? Maybe not, but you determine that selling 1,000 is. Then you know that to profit $10,000 per month, you would need to raise prices, lower costs, or a combination of both.

You have an excellent idea for a business. Start with a financial forecast, which will show whether or not your idea is feasible. Once you create a reasonable business plan, you can start legally setting up the business as an LLC (if that’s your choice), including registering with the Secretary of State and obtaining the EIN from the IRS. Once you launch your business, you can compare what’s happening with what you projected and make necessary adjustments.

Social Security Benefits and Location, Location, Location. Most retirees don’t have unlimited income, so any extra cash that can be preserved via good tax planning is incredibly significant. One easy way to do this is to live in a low-tax state. Currently, nine states don’t have income tax (Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming), and another 31 states don’t tax social security benefits at all. Living in a state with income tax but no tax on social security benefits could save you thousands of dollars per year.

Keep in mind that there’s no escaping the tax collector’s reach. Living in places with lower income taxes might seem appealing, but it often comes with higher sales and property taxes. It’s important to consider all the factors before moving to a different area.

By Mark Toney
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